INTRODUCTION TO BASIC ECONOMICS 2.
How to produce the goods and services
Economics is a social science that studies how individuals,
governments, firms, and nation make choices on allocating scare
resources to satisfy their unlimited wants.
Division of Economics
Macroeconomics is a branch of economics dealing with the
performance, structure, behavior, and decision-making of an economy
as a whole, rather than individuals’ market.
Microeconomics is a branch of economics that studies that behavior
of individuals and small impacting players in making decision on the
allocation of limited resources.
Economic Perspective
• The making of purposeful decisions in the context of marginal costs
and marginal benefits.
• Is a viewpoint that envisions individuals and institutions making
rational decisions by comparing the marginal benefits and marginal
costs associated with their actions.
Application of Economics
Economics has many practical applications in daily life. Although
many people are not aware of this, we incorporate the principles of
economics in different situations: a mother shopping at the grocery
store for dinner, teenagers deciding how to spend their summer and a
driver calculating his route are just a few examples.
Importance of Economics
• Economic is the study of choices and behaviors. Economics focuses
on why we make the choices we do. And what the implications or
effects of those choices are.
• The main importance of economics is to help a society decide on the
best allocation of the resources. It also helps to decide on questions like
what to produce, how to produce it and for whom to produce.
ECONOMICS AND OTHER SCIENCES
History
Geography
Determinant, Cultural Geography, Development and
Evolution
Political Science
Influential Theories
Psychology
It helps Economists: Needs, Wants
Mathematics
Quantitative Methods – Statistics
BASIC ECONOMIC PROBLEMS
• All countries have economic problems, including the richest
countries.
• However, the poorest countries have the biggest and longest
economic problems.
• In the case of the poor countries, they can not even provide most of
the basic needs of their peoples.
• There are no possibilities of erasing completely economic problems
from the face of the earth.
• On the other hand, the needs of the people are increasing due to
population .
• That is why even the rich countries have economic problems.
Three Basic Economic Problems
1. What goods and services to produce and how much
In business, a feasibility study determines whether certain
goods and services become profitable or not in a given market.
In reality, however it is not always possible to produce all
the goods and services that people need, because resources are limited.
In the poor countries, there is no need to conduct survey to
determine the real needs of the people.
As a general rule, goods and services must be produced in
the most efficient manner.
The application of modern technology has increased output
and decreased cost of production.
In the case of the poor countries, they can not afford to apply
modern technology.
For this reason, it has been suggested that poor countries
should use labor-intensive technology. This means more labor and less
machine.
3. For whom are the goods and services
This is a problem of distribution.
Who gets the goods like rice, clothes, shoes, and the services
such as education, Medicare, etc.
The rich have several cars, mansions and elegant clothes and
jewelries.
In contrast, the poor, especially the poorest, can only acquire
goods and services depending on their purchasing power.
However, in other economic systems, the government
interferes in the distribution of goods and services in order to protect
the welfare of the poor.
ECONOMICS
Several ways of defining economics:
1. Economics is the study of wealth.
2. Economics is the study of how human being go about the business
of organizing consumption and production activities.
3. Economics is the study of how to improve society and make human
civilization possible.
4. Economics is the science that allocates scarce resources to satisfy
human wants.
Economic System
Deals with producing, distributing, and consuming goods and services.
Market Economy
An economy in which decisions regarding investments,
production, and distribution are based on supply and demand.
Example: free enterprise and capitalism
Command Economy
An economy where supply and price are regulated by the
government rather than market forces.
Example: socialism and communism
Traditional Economy
Any economic system involving extensive subsistence
agriculture or one that otherwise falls outside the definitions of market
or planned economies.
Example: Non-industrialized agrarian societies
Mixed Economy
An economic system in which both the state and private
sector direct the economy.
Economic System is necessary:
• To determine the ends to be served by production. Problems first must
be resolved:
What goods and services shall be produced?
In what amount shall they be produced?
For whom shall they be produced?
How shall they be produced?
• To allocate the productive resources – land, labor, capital, and
direction among the variety of goods and services to be produced.
• To distribute among the members of society the total wealth
produced. The more economic goods are shared by the people, the
higher is their standard of living which is one of the goals of every
economic society.
• To make provisions for economic growth. For an economy to grow,
it must accumulate what Adam Smith called stock, or what we may
call capital goods, that is, wealth used not for the direct satisfaction of
human wants but for further production.
Role of Economic System to Economic Activities
The role of the economy is to establish formal relationship
among people as their daily business of living. All economic activities
are affected by the various phases of business cycle, whether it be
production, exchange or even consumption. All economic societies
cannot escape from the effects of a business cycle which defines as “a
series of changes in business activity, commonly characterized by
periods of alternating prosperity and depression which extended over
a period of several years”.
Studies of business trends have brought to light not one but
two major types of cyclical movements which characterize our
economic system. They are Major Cycle and Minor Cycle.
Major Cycle - generally brings in their path the appearance of severe
depression.
Minor Cycle - the oscillation of business activity while noticeable is
far from severe. The downward movement is slight.
Four Distinct Phases
The Period of Prosperity
The Period of Recession or Period of Liquidation
The Period of Depression
The Period of Recovery
Different Market Structures/Situations
Adam Smith was one of the first to develop the concept of
free competitive market and thus to expound on its advantages.
1. Monopolistic Competition/Competitive Market
where there are a large number of firms, each having a small
proportion of the market share and slightly differentiated products.
2. Oligopoly
from the Greek word “oli” meaning “a few” and “polein”
meaning “to sell”, may be defined as a form of imperfect competition
in which there are few sellers in the market. In which a market is
dominated by a small number of firms that control together the
majority of the market share.
3. Monopsony
there is only one buyer in a market.
4. Oligopsony
where many sellers but meet only a few buyers.
5. Pure Competition
the competitive process functions so effectively that no firm
has any control over the price it will receive for its products.
6. Monopoly
it means control over supply, and therefore over the price.
Where there is only one provider of a product or service. This means
there is one producer of the product, and as a result the size of his
output influences the price so that the producer may receive a
monopoly profit.
Market - means the general conditions under which buying and
selling are conducted. It provides a link between consumers and
producers.
Market Economy
Economic system in which economic decisions and the
pricing of goods and services are guided solely by the aggregate
interactions of a country’s citizens.
Involved in goods and services for consumption. The
modern market economy which a profit-oriented economy. Through
the price of mechanism, the market transmits the desires of consumers
to retailers, from retailers to wholesalers, and wholesalers to the
various manufacturer and producer of a raw materials.
The Prevailing Market Economy
In a market economy, national and state government play a
minor role. Instead, consumers and their buying decisions drive the
economy. In this type of economic system, the assumption of the
market plays a major role in deciding the right path for a country’s
economic development.
Role of the Government Intervention in the Mixed Economy
• Government intervention in the economy consider significant to
protect against the worst elements of capitalism.
• The government should take a limited role in the economy while
allowing private enterprises.
Benefits:
1. Government regulations allow businesses to remain in the private
hands while removing some of the worst abuses of a pure capitalism.
2. A government intervention protects the consumers, producers, and
community as a whole.
3. Limited government involvement prevents crisis.
ECONOMIC ACTIVITIES
• Involves the use of scarce resources in the provision of goods to
satisfy unlimited wants.
• Include activities such as buying, selling, investing, borrowing,
lending, mortgage, loans, etc. Economic activities are extremely
important for a society or a country.
• The set of activities realized by the human beings to satisfy his needs.
• The economic activities produce the goods and give the services that
the persons need or wish.
Generally, economic activities are the activities which are
done in purpose of earning money to fulfill the wants of the people
which are unlimited and unending.
Factors of Economic Activities
The economic activities are set of activities carried out by
human beings to satisfy their needs. The economic activities produce
goods and give services that people need or wish.
• Production
The processes and methods used to transform tangible inputs
(raw materials, semi-finished goods, subassemblies) and intangible
inputs (ideas, information, knowledge) into goods or services.
Resources are used in this process to create an output that is suitable
for use or has exchange value.
Factors of production means inputs and finished goods
means output. Input decides the quantity of output i.e., output depends
upon input. Input is the starting point and output is the end point of
production process and such input-output relationship is called as
“Production Function”.
The production of goods needs natural resources,
technology, and work. People produce two types of goods: Production
Goods – ex: Shoe Machine
Consumption Goods – ex: Shoes
The production of services needs organization and
infrastructures (like a Highschool in the Educational System).
• Commercialization and Distribution
It refers to the way total output, income, or wealth, is
distributed among individuals or among the factors of production (such
as labor, land and capital).
Storage
I
Commercialization and distribution include:
Transport Sale – Wholesale and Retail
• Consumption
We can satisfy our need through consuming goods. If we buy
material goods, we are consumers. When we use a service, we are
users.
• Growth
Develop or research again the product to be more adaptive
of needs. It involves innovation.
Types of Economic Activities
Primary Group: employs people to collect or produce natural
resources from the land or sea, like farming and fishing. i.e., raw
materials.
Secondary Group: makes or manufactures goods, like car assembly.
i.e., industry and manufacturing.
Tertiary Group: provides services for people, like the Highschool.
i.e., services.
Quaternary Group: a new definition related with high technology
service, industry that carries out research and provides information and
advice. i.e., knowledge sector.
Capitalism: Market Economy
The fundamental idea is that fair prices are only obtained
with the law of supply and demand, which helps people to satisfy their
needs better.
Market is the place where we can buy and sell goods. In
markets, we find sellers (supply) and buyers (demand). Sellers want to
obtain the highest profit and buyers want to obtain the lowest prices.
For capitalism, the relation between buyers and sellers must be free.
Prices depend on the quantity of goods and buyers. If there
are too many buyers in the market and few goods, prices will rise. If
there are many goods in the market, prices will go down. Other factors,
like publicity can change markets and prices. This is the law of supply
and demand.
Economic Agents
Citizens, lobbies, companies, or public and private
institutions are parts of the markets. They are the economic agents. The
most important are:
• Families: Each family uses a big part of their wages to buy goods
and services.
• Companies: Produce and distribute goods and services. They need
work and capital. Capital is the set of resources that one company must
use to produce something: money, buildings, tools, etc. Cost price is
the price of production: raw materials, energy, transport, wages, taxes,
etc. Market price must be higher than the cost price. The difference
between the two is profit. Companies can be primary, secondary,
tertiary, and quaternary according to their activity. But according to
their size, the companies can be multinational (corporations), large,
middle, and small.
• Public sector: The group of economic and social activities that States
must offer to the citizens.
- To support the public administration (central
government, regional government, town council).
- To promote the economic activity and the social
relations with infrastructures, public works…
- To offer public services, as education, health, transport,
police…
Normally, States use taxes and other income to pay for these services.
MONEY AND PRICE
Money is any object or record that is generally accepted as payment
for goods and services and repayment of debts in a given socio-
economic context or country.
Money, like water, it needs to flow. Dead water is potential
as pool of illness. It needs to circulate and that means we have to spend
it wisely.
3 Simple Rules on how to Balance Money
Rule 1: Money has to flow in order to stay alive and grow.
Rule 2: Never spend more than you have.
Rule 3: Always dare to spend it when there is a potential to receive
more.
Function of Money
Money is often defined in terms of the three functions or
services that it provides. Money serves as a:
Medium of Exchange
Money’s most important functions is as a medium of
exchange to facilitate transactions. Without money, all transactions
would have to be conducted by barter, which involves direct exchange
of one good or service for another.
Store of Value
In order to be a medium of exchange, money must hold its
value over time; that is, it must be a store of value. If money could not
be stored for some period of time and still remain valuable in exchange,
it would not solve the double coincidence of wants problem and
therefore would not be adopted as a medium of exchange.
Unit of Account
Money also functions as a unit of account, providing a
common measure for the value of goods and services being exchanged.
Knowing the value or price of a good, in terms of money, enable both
the supplier and the purchaser of the good to make decisions about how
much of the good to supply and how much of the good to purchase.
Price is the quantity of payment or compensation given by one party
to another in return for goods or services.
Price System is any economic system that affects its distribution of
goods and services with prices and employing any form of money.
Except for possible remote and primitive communities, all modern
societies use price systems to allocate resources. However, price
systems are not used exclusively for all resource allocation decisions.
Types of Price System
Fixed Price System
The government sets a ceiling on how high prices can be for
either all or selected items. When only a few items have fixed prices,
it is also called a mixed price system. Fixed prices are usually enforced
in an attempt to lower or cap inflation. A system that fixes prices may
be used to aid lower income populations or to stabilize a struggling
economy.
Free Price System/Free Price Mechanism
An economic system where prices are set by the interchange
of supply and demand, with the resulting prices being understood as
signals that are communicated between producers and consumers
which serve to guide the production and distribution of resources.
Through the free price system, supplies are rationed, income is
distributed, and resources are allocated.
Types of Pricing
Mark-up Pricing
The difference between the costs of producing and selling a
product and the market selling price of the product.
Target Return Pricing
Determines the demand and identifies desired profit.
Going-rate Pricing
Charges the average price of what its competitors.
Value-based Pricing
Prices perceive by consumers.
VALUE AND PRICE
Value is a measure of the benefit that an economic actor can gain
from either a good or service.
It is generally measured relative to units of currency, and the
interpretation is therefore “what is the maximum amount of money a
specific actor is willing and able to pay for the good or service”?
Price is the amount of money that has to be paid to acquire a given
product. Price is also a measure of value.
The Difference Between Value and Price
In capital markets, price is set by the most panicked seller at
the end of a trading day; value, which is determined by cash flows and
assets, is not.
This is both the challenge and the opportunity of investing:
to carefully sift through the markets to find the greatest divergence
between price and value, and to concurrently avoid the extreme
emotions of the crowd and, indeed, to take a stand against them.
THE LAW OF SUPPLY AND DEMAND
Determinants of Supply Explained
• Technology
This refers to the techniques or method of production.
Modern Technology: which uses modern machines and
increases the supply of goods.
• Cost of Production
In producing goods, raw materials are needed, together with
the laborers.
If the price of raw materials or the salaries of the laborers
increases, it means higher cost of productions.
• Number of Sellers
More sellers or more factories mean an increase in supply.
Conversely, smaller number of sellers or factories means less supply.
• Prices of Other Goods
Changes in the price of goods affect the supply of such
goods.
• Price Expectations
If producers expect prices to rise very soon, they usually
keep their goods and then release them in the market when the prices
is already high.
This creates artificial shortage due to hoarding.
• Taxes and Subsidies
Certain taxes increase cost of production.
Higher taxes discourage production because it reduces the
earnings of businessmen.
Law of Supply
As price increases, quality supply also increases, and as price
decreases, quantity supply also decreases.
Ceteris Paribus
This means the law of supply is valid if the determinants of
supply like cost of production, technology, prices of other goods, and
so forth are held constant.
Illustrations: Market Price P20 Disequilibrium: Excess
Cost of production 15 Demand
Profit P5 Excess demand is created
when price is set below the
If price increases from P20 to P23 and the cost of production remains equilibrium price. Because
the same, the producer gets more profit. the price is so low, too many
Market Price P23 consumers want he good
Cost of Production 15 while producers are not
Profit P8 making enough of it.

Law of Demand
• It states that people will buy more of a product at a lower price than
at a higher price, if nothing changes.
• It states that at a lower price, more people can afford to buy more
goods and more of an item more frequently, than they can at a higher
price.
• It states that at lower prices, people tend to buy some goods as a
substitute for others more expensive.

Income Effect
At lower prices, an individual has a greater purchasing
power. This means he can buy more goods and services. But a higher
prices, naturally he can buy less.
Substitution Effect
Consumers tend to buy goods with lower prices. In case the
price of a product that they’re buying increases, they look for
substitutes whose prices are lower.

Ceteris Paribus - Validity of the Law of Demand

All other things equal or constant. The law of demand is
correct if the determinants of demand are held constant.
Tastes and preferences determine the demand for a product.
If people do not like the product, their tendency is not to buy it even if
the price is reduced. Thus, to make the law of demand valid, we always
assume that tastes or preferences do not change.

The Law of Demand

The demand relationship curve illustrates the negative
relationship between price and quantity demanded. The higher the
price of a good the lower the quantity demanded (A), and the lower the
price, the more the good will be in demand (C).

The Law of Supply and Demand states that when supply is greater
than demand, price decreases. When demand is greater than supply,
price increases. When supply is equal to demand, price remains
constant.

Equilibrium

Disequilibrium: Excess
Supply
If the price is set too high,
excess supply will be
created within the economy
and there will be allocative
inefficiency.